Oil Prices Hit Two Month Low

The lack of demand and the rising inventory levels combined to pressure prices on crude on Monday. The big gain in inventories last week and the comments out of OPEC about lack of compliance with current quotas and the debut of the sour crude futures on the CME combined to push oil prices below $74.

Over the weekend OPEC members argued among themselves about the rising cheating and non-compliance with the 4.2-mbpd cuts enacted last December. With compliance falling rapidly towards 50%, currently 60%, the inventory levels in key markets around the world are rising. Demand has failed to grow as quickly as some had hoped. Still OPEC put on a solidarity face and everyone said there would be no production change at the December meeting. There was talk about monitoring compliance but it never happens. If non-compliance is found the member nation simply says tough and continues. There is no formal discipline method.

The CME relaunched the Gulf Coast Sour Crude Futures starting today. The Nymex tried to trade it several years ago but never found an audience because the world was trading light crude. When Saudi Arabia and Kuwait announced recently that they would price oil sold to the USA according to the Argus Sour Crude futures it created an instant audience.

The delivery point of light crude futures is Cushing Oklahoma. Cushing can only store about 35 million barrels of crude and this causes a problem with prices when storage is full as happened earlier this year. The sour crude contract will have a delivery point of the Louisiana Offshore Oil Platform (LOOP) in Clovelly LA. The LOOP feeds many pipelines and refiners in the gulf area and is not thought to have the same problems as Cushing.

Another reason the sour crude contract makes more sense for OPEC members is that less than 15% of the oil imported into the USA is light crude. We produce light crude in the U.S. but we mostly import sour crude because that is what most OPEC countries produce.

I would bet that the sour crude contract is going to be extremely volatile whenever a hurricane approaches the gulf. The WTI contract has always been volatile around storms but for different reasons. If a hurricane heads for LA then the sour futures could swing wildly. When Katrina hit and knocked the LOOP offline for many days there was no readily available contract for oil delivered there. If the LOOP was knocked out again you can bet the contract will reflect it.

Crude prices declined to $73.70 on Monday and recovered slightly at the close. It appears that $74 could be short term support but that depends on the dollar and the inventory report on Wednesday.